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The sum of all tightenings

The world has stepped on a monetary brake. And I don’t think it will end well.
Go back a few months. Remember how the US economy continued to defy gravity and kept surprising to the upside? When the PMIs in the eurozone moved north and it was just a matter of time before Europe lifts itself out of the recession? When the Chinese government was trying to do everything to make the growth outlook look good ahead of the party plenum? These were very good times. There were two main consequences of such a behaviour:
1) the market consensus for 2014 growth shifted higher;
2) the whole world concluded that duration is dead and equities will keep going up.
Policymakers also saw that and they responded. Independently from each other.
– The Federal Reserve began to taper the QE infinity programme. We could of course spend 3 days arguing whether tapering is tightening (and it wouldn’t be wasted 3 days!) but for the purpose of this discussion let’s assume tapering did tighten the policy at a margin. Ok, if you really hate this then think of it as less loose policy.
– The ECB lost any sense of urgency and allowed continued repayments of the LTRO to shrink its balance sheet and lead to a bit of a mess in the money market at the turn of the year (think Eonia).
– The PBoC started providing less liquidity to the Chinese banking sector thus driving rates considerably higher.
– The Bank of England allowed the forward (mis)guidance to go to hell thus letting market rates go up.
– Some emerging economies (like Brazil or India) kept hiking interest rates, although admittedly it was for different reasons than stellar growth prospects.
– Furthermore, in January many emerging economies were forced to hike interest rates to defend their currencies (Turkey, South Africa) and those who escaped that fate saw money market rates jumping anyway (eg Russia).
– Finally, RBNZ and RBA shifted their rhetoric to a more hawkish.
I probably missed a few but you get the picture. What seemed like a rational decision on individual country level, doesn’t necessarily have to be a good thing when compounded though. And this is something that RBI Governor Rajan meant in January when he talked about the lack of global policy co-ordination.
And guess what? The data has started coming in weaker (and don’t give me the boring weather explanation). Fine, it’s not a train smash yet and arguably expectations were elevated to start with but I think the market needs to seriously rethink its global growth forecasts. This is particularly the case as both inflation and wages keep surprising to the downside.
Note that anyway a lot of last year’s global improvement happened in soft data such as PMIs rather than actual output. This was most visible in the eurozone. It seems that people were simply relieved that the acute phase of the crisis is over. But in fact they didn’t start “buying more stuff”.
Finally, I would like to state what I think about the whole question whether developed economies should care about emerging ones. I get tons of messages saying that the recent debacle in EM means nothing to Yellen. Well, the Fed doesn’t care about EM… until it does.
Emerging markets excluding China are running a cumulative current account deficit of around 250bn USD. It is undeniable that after January this number will shrink as many EMs will see their consumption levels dropping. For instance, S&P said this week that the current account deficit in Turkey would shrink from 60bn to 20-ish bn this year. This is 40bn USD removed from global demand. And there will be more of that in other places. You think it doesn’t matter and that the Germans will keep selling their BMWs and the Americans their IPads to China, Russia and Brazil at the same pace as before? Well, good luck with that!

If you believe in the Quantity Theory, the world is headed toward recession. It’s all there in the money growth data. When the recession does happen, we will be informed that it was “unexpected” and “puzzling”.

I have never understood the argument for “global policy coordination”. Prosperity in one economy has never required cooperation; it is an exude for failing to inflate. France outperformed the ROW in the 30′s because she wasn’t overvalued–it had nothing to do with anyone else. Read temin or Eichengreen.